Definition
Under ASC 323, an investor applies the equity method when it can exercise significant influence over an investee, such as through board representation, policy participation, or material transactions. Holding 20% or more of the voting stock leads to a presumption of significant influence, absent evidence otherwise. The investment starts at cost, then the investor recognizes its share of the investee's net income or loss in earnings and reduces the carrying amount for distributions received. Basis differences from fair value are amortized or accounted for as appropriate.
Why it matters in an audit or review
Auditors obtain the investee's financial statements, test the investor's share and adjustments for differences in accounting policies, and assess impairment when a decline in value is other than temporary. Differences in fiscal year ends and negative carrying amounts need specific attention.
Example
(Illustrative, assuming no basis difference) A company pays $1.0 million for 30% of an affiliate. The affiliate earns $400,000 and distributes $100,000.
Dr Investment in affiliate 120,000 Cr Equity in earnings 120,000 Dr Cash 30,000 Cr Investment in affiliate 30,000
Ending carrying amount is $1,090,000.
Common mistakes
- Recording distributions as income.
- Ignoring losses once the carrying amount is zero.
Sources
- FASB ASC 323-10-15, Investments-Equity Method and Joint Ventures, significant influence and the 20 percent presumption
- FASB ASC 323-10-35, Investments-Equity Method and Joint Ventures, applying the equity method
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error